Drawing lessons from the experiences of the East Asian tigers, China stepped up efforts to develop its high technology sectors as early as the 1990s. As China’s domestic economy was not able to provide substantial kick-start investments in these sectors, financial incentives to attract foreign direct investment (FDI) in these sectors were considered necessary. FDI in high technology sectors — such as semiconductors, optical devices, high-performance computers, newly innovated TVs etc. — that China had technological or financial difficulty to develop by itself was encouraged.
With the policy support, the high technology industry has become dominant in China’s FDI profile as well as in its domestic production. Consequently, it has resulted in the large import of machinery and electrical equipment from foreign investors’ home countries. The high-tech content of China’s exports has also been strongly dependent on foreign technology embedded in the processing trade.
However, the Chinese government’s initiatives to upgrade the industry through “Made in China 2025” show the limits of advancing its level of technology through FDI. Such an industrial upgrading plan has drawn worldwide attention. In particular, the United States is concerned that China’s technological advancement will hurt its business interests and political supremacy in the world.
Developing the High Technology Industry
In the 1990s, several concrete measures for promoting FDI from labor-intensive to technology-oriented electronic manufacturing were proposed and implemented. According to China’s official statistics, 55-70 percent of the utilized FDI was in manufacturing sectors during the 1997-2006 period, with the biggest concentration in electronic and telecom equipment.
The large FDI in the high technology sectors has changed China’s industrial structure. China’s industrial output for electric machinery and equipment and electronic and telecom equipment surged from just RMB 168 billion in 1991 to RMB 11,522 billion in 2011. In terms of total industrial output, the share also jumped from 6 percent in 1997 to 14 percent in 2011, making it the second largest industry in the country, after ferrous and non-ferrous metals (15 percent of total industrial output) in 2011 (Data source: CEIC).
China’s industrial structural changes can also be observed from its changing export composition. Communication equipment was China’s largest export item (USD 204 billion), followed by computers (USD 175 billion), and electronic equipment and components (USD 121 billion) in 2016 (2017 Yearbook of China Information Industry 2017). This is in contrast to 20 years ago when China exported mostly textile, metal, and other low technology products.
The development of China’s production in computer, communication and other electronic equipment and electrical machinery allowed it to become a dominant player in the global Information and Communication Technology (ICT) industry. The country was the largest global exporter and importer of integrated circuits and electronic components in 2014, and the largest exporter and third largest importer of telecom equipment in the world (WTO 2015). Most of China’s ICT exports are made by foreign firms in China. In 2016, 51.1 percent of China’s ICT exports and 50.2 percent of its ICT imports were made by wholly foreign-owned firms in China, up from 32.5 percent and 28.2 percent in 1996, respectively (Table 1).
In comparison, China-foreign joint ventures accounted for nearly 17 percent of the country’s exports and imports in ICT products in 2016, declining from about 40 percent in 1996. Private Chinese firms emerged from almost zero in 1996 to a respective 24 percent and 26.6 percent of its exports and imports in 2016. In comparison, the share of state-owned enterprises has registered a clear drop in the last two decades.
Table 1. China’s trade in ICT goods by type of enterprises (as percent of total exports in ICT goods/electronic products)
Source: 2017 Yearbook of China Information Industry, 2017; Yearbook of China Electronic Industry, Electronic industry Publisher, Beijing, 1997 (in Chinese).
Limited Technology Transfer
To facilitate the absorption of advanced technologies from abroad, China issued the “Catalogue of Encouraged High-Tech Products for Foreign Investment” in 2003 and amended the “Catalogue for the Guidance of Foreign Investment Industries.” FDI in high technology, high-end production, and high-end services are encouraged (Chen, 2011). According to China’s “Medium and Long-Term Plan for Science and Technology Development” (MLP) issued in 2006, if foreign companies wanted to compete for government contracts and subsidies promoted under indigenous innovation policies, they had to transfer their proprietary technology and intellectual property to their Chinese partners. Nonetheless, these policies led to a backlash from foreign governments and companies and were subsequently abolished in 2011 (Raheja 2016).
Joint ventures are also encouraged by the Chinese government to facilitate technology transfer to local firms. Nonetheless, joint ventures between Chinese and foreign firms in China’s total FDI declined visibly from 43.6 percent of total FDI in 1997 to 23.4 percent in 2017. Cooperative ventures also decreased from 23 percent to 0.7 percent during the same period. In comparison, foreign enterprises climbed from 34.9 percent to 69.3 percent (Figure 1).
Figure 1. China’s FDI by investment type 1997-2017 (as percent of total utilized FDI)
Despite FDI’s significant presence in China’s high technology production, foreign firms do not make a large contribution to China’s R&D. In 2016, foreign invested firms, including FDI from Hong Kong and Macau, accounted for only 22 percent of China’s total intramural R&D spending compared to 78 percent of R&D expenditure spent by China’s domestic firms. Foreign firms in China hired 21 percent of total R&D personnel in China whereas Chinese firms employed 79 percent (Table 2).
Indeed, foreign governments are cautious about technology transfer to China through FDI. For example, Taiwan Semiconductor Manufacturing Company (TSMC) was allowed to invest in a plant for its 12-inch wafer fabrication lines in Nanjing, China in 2017 after it was able to manufacture three-inch wafers in Taiwan (smaller size but with higher technology intensity). Beyond government rules, the private sectors also prefer to develop R&D at home. For example, according to the official survey, most Taiwanese firms in China still rely on the home company in Taiwan for technology. Only a small number of Taiwanese firms in China would invest in R&D (Chung-Hua Institution for Economic Research 2017).
Table 2. China’s R&D activities by type of enterprise in 2016 (as percent of total R&D)
Source: China Statistical Yearbook on Science and Technology, China Statistics Press, Beijing, 2017.
Note: Intramural expenditure on R&D refers to expenditure on internal R&D activities. External expenditure on R&D means that R&D is outsourced to external institutions or cooperates with external institution to conduct R&D.
Technology Gap with Major East Asian Economies
According to the Global Innovation Index 2017, China was ranked the 22th most innovative country out of 127 countries in the world, progressing from 43th in 2009. China enjoys a relatively high ranking in knowledge and technology output (4th), human capital and research (25th), and ICT infrastructure (27th), compared to most countries. Despite China’s technological progress, major East Asian economies such as Japan, South Korea, and Taiwan are still superior in technology. In 2017, China was ranked 95th out of 139 countries in the “availability of the latest technology” whereas Japan, South Korea and Taiwan ranked the 16th, 31th and 36th respectively. The same report also identified China as lagging behind Japan, South Korea and Taiwan in terms of “firm-level technology absorption”, “capacity for innovation”, “ICT patent and application per million population” (Baller, Dutta and Lanvin 2016).
China’s lag in its level of technology can also be observed from its external trade relations with neighboring countries. Despite China’s phenomenal growth and its leapfrogging in industrial development and movement up the industrial value chain, it is still highly dependent on its main Asian trade partners, particularly South Korea, Japan, and Taiwan. Japan, South Korea, and Taiwan’s large trade surplus vis-à-vis China (or China’s still large trade deficit with them) indicates that the three countries still possess more comparative advantages in producing high technology and capital-intensive goods.
As shown in Figure 2, China’s trade deficit with Japan developed quickly in the 2000s. It had narrowed from USD 55.6 billion in 2010 to USD 7.1 billion in 2015. In comparison, China’s trade deficit with South Korea and Taiwan has continued to widen after 2010. During the 2014-16 period, China’s trade deficits with the three economies had shown signs of improvement due to the slowing down of global demand, which could have resulted in China’s decreased imports for manufacturing production. With the global economic recovery, China’s deficit with them worsened in 2017. Of the three economies, China has the biggest trade deficit with Taiwan in the last two decades as Taiwan’s smaller economic size has constrained China’s exports to the island. With less exports, its trade deficit with Taiwan is much larger.
Figure 2. China’s merchandise trade balance with Japan, South Korea and Taiwan 1997-2017
China’s main sources of trade deficit with Japan, South Korea, and Taiwan have been increasingly inclining towards capital and technology intensive products. In 1997, machinery and electrical equipment was China’s largest source of trade deficit with Japan, tripling from USD 8.2 billion to USD 31 billion in 2007 and USD 20.2 billion in 2017 (Table 3). In 1997, China’s trade deficit with South Korea was mainly in plastics and rubber (USD 2.2 billion), but by 2017, machinery and electrical equipment had become the largest source, followed by chemical products (USD 11.3 billion) and optical photographic and musical instruments (USD 11.2 billion). Similarly, machinery and electrical equipment is China’s main source of trade deficit with Taiwan, expanding speedily from USD 4.3 billion in 1997 to USD 85.6 billion in 2017.
Table 3. China’s trade balance with Japan, South Korea and Taiwan by main items (USD billion)
Investing in China allows foreign firms to expand their economies of scale. At the same time, large foreign companies also play an important role in China’s external trade. In 2016, among the top 50 firms in China’s external trade, 16 were Taiwanese and eight were Korean. Most of them were affiliates of Taiwan’s Foxconn Technology Group and Korea’s Samsung Group. China’s own branded ICT products have emerged in recent years. However, due to the lack of key technology, Chinese producers have continued to rely on foreign imports of key components to ensure their products’ reliability. As such, China’s imports of industrial goods have remained large despite the rise in Chinese branded products in recent years.
China has tried to upgrade its position in the global value chain and reduce its reliance on foreign imports of high technology goods through enormous R&D spending. China’s R&D expenditure as percentage of GDP increased from 1.32 percent in 2005 to 2.05 percent in 2014. In terms of absolute amounts, China spent USD 336.5 billion in R&D in 2014, much greater than Japan’s USD 135 billion, South Korea’s USD 68.9 billion, and Taiwan’s USD 30.7 billion (Ministry of Science and Technology, 2016). A good 76.1 percent of China’s R&D was financed by private companies, much higher than the ratios in other advanced countries (National Development Council 2016; China Statistical Yearbook on Science and Technology 2017).
In 2015, China issued “Made in China 2025,” which aims to comprehensively upgrade its manufacturing sectors and high value-added services industry. The plan sets the goal of raising domestic content of core components and materials to 40 percent by 2020 and 70 percent by 2025. The plan also calls for strengthening Intellectual Property Rights (IPR) protection and participate in international standards setting. The immediate challenge for East Asian economies from this ambitious plan is the potential declining demand from China if it is able to successfully increase the local content of key components. China’s increase in locally-made components will imply the loss of a growth engine for East Asian economies.
The enhancement of IPR protection could also promote technology transfer to China. However, foreign countries’ intention to protect their core technology and political distrust of foreign governments towards China will hinder such technology transfer. China-US political rivalry is another deterrent to China climbing up the production chain. Hence, despite China’s ambition, abundant resources, and capacity, the political factors are disadvantageous for the country to move further up the high technology ladder anytime soon.
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